NRIs going to the USA may want to start their own business. There may also be aspiring Indians, who are not NRI or US citizens, looking to structure business in USA to expand. Key options for structuring business in USA include: Sole Proprietorship, Partnerships (General Partnership and Limited Liability Partnership) , Corporations (S Corp & C Corp) and Limited Liability Corporations. There are tradeoffs and tax impacts to be considered while choosing a specific structure or changing the same with evolving need.
Any person can conduct business for him or herself as sole proprietor, without registration as a business entity with the state business entity filing office. A sole proprietorship is the simplest form of business structure and is not a separate legal entity. This person who is the owner makes all of the decisions and all profits and losses belong to this person which is recorded as part of his or her income in the Income tax return. The business itself is not taxed.
Some formalities such as permits or licenses may be necessary where state or local law requires them for a particular type of business, example, a restaurant operator may need special permits, such as a liquor license, to conduct business or plumbers, attorneys, accountants and other trades and professions need licenses from the state to perform these services. If the sole proprietorship is engaged in an activity subject to state and local sales taxes, a sales tax certificate must be obtained. If the business employs people, a Federal Employer Identification Number must be obtained. Also, when the sole proprietor conducts business under a name other than his or her true name, then state law determines how and when assumed/fictitious/trade names must be filed.
The major disadvantage to operating as a sole proprietorship is that the sole proprietor is personally liable for the business’ obligations. If the assets attributed to the business are not sufficient to meet the business’ obligations, the personal assets of the sole proprietor can be used to satisfy those obligations. Another limitation is that while the loss in business can be setoff with other income or carried forward, the IRS may question and disallow the carryforward or setoff if repeated losses are shown without reason.
For reporting Income tax form 1040 and Schedule C (Profit & Loss from sole proprietor business) is used. Other key IRS requirements for filing include a) Schedule SE (Self Employment Tax, if profit) of Form 1040, b) Form 941 (Quarterly Return) for Social security and Medicare taxes and income tax withholding c) Form W-2 (Wages and Tax Statement) for Providing information on Social security and Medicare taxes to employee and Form 3 to social security agency and d) Form 940 (Annual Return) for Federal unemployment (FUTA) tax. A sole proprietor pays self-employment tax of 15.3% (Social Security and Medicare) on all profits.
If two or more persons agree to do business together, a partnership is formed via a partnership agreement. All states have statutes dealing with partnerships. These statutes mostly contain default provisions that will apply only if the partners have not addressed those issues in their partnership agreement. These statutes provide, for example, that unless there is a partnership agreement providing to the contrary, all partners have equal rights to manage the partnership. They also share equally in the profits and losses and distributions of income. It is also provided that each partner is considered an agent for the partnership and may bind the other partners in connection with the partnership business.
A partnership may be formed informally by oral agreement, or formally by a written partnership agreement. However, it is usually advisable to have a written partnership agreement. A partnership has many of the most attractive aspects of a sole proprietorship. It is easy to start up and run. A partnership does not have to pay an entity level income tax. It is a “flow through” entity. Its profits and losses flow through to the partners. However, a partnership also shares the sole proprietorship’s most unattractive aspect-unlimited personal liability for the business’ debts. The partnership that has this unlimited personal liability feature is called ‘general partnership’.
There is also a partnership where liability is limited and is called ‘limited liability partnership’. This structure is often used by professionals, such as attorneys and accountants. To operate as an LLP, a state filing and a registered agent is required. A general partnership may become an LLP by filing a registration document with the secretary of state or other proper filing officer. Or, in some states, an LLP may be newly formed without having been a pre-existing General Partnership. A limited liability partnership doing business in a state other than its formation state will have to register with that state as a foreign limited liability partnership before transacting business there. In addition, in most states, limited liability partnerships are required to file an annual report.
The partners are taxed on their share of profits received via Form 1065 (K-1 Schedule). Form 1065 (Return of Partnership Income) is an information return and no taxes paid at partnership level. The individual Partners will file Form 1040 and select employment tax in Schedule SE of Form 1040. In addition to income taxes, the IRS requires partners to pay “self-employment” taxes on all partnership profits allocated to them.
There are two types of corporations. These types can be considered as the Simple version (S) or the Complex version (C).
S Corporations has a separate corporate business entity. In order to become an S corporation, the corporation must submit Form 2553 (Election by a Small Business) signed by all the shareholders. This grants S Corporation features such as is a “Pass through” structure for Tax purposes and restrictions in terms of number of shareholders (max 100) and can have no no-resident alien shareholders. Only one class of shares are allowed. This is meant for small business and corporations. A EIN# from IRS and a separate business name is obtained from the state.
At year end the S Corp files form 1120S and schedule K-1 for the share of profits that gets reported in the shareholders tax returns via form 1040. A reasonable salary (per industry standard) is expected to be paid to employees who are shareholders and payroll taxes (employer and employee share adding to 15.3%) applies. The tax will not apply to the distribution as profits portion.
C Corporations (or just called Corporation ) do not have the restrictions of S corporation in terms of number of shareholders (can be more than 100) and can have no-resident alien shareholders. Different class of shares are allowed. It is meant for large corporations and has more procedures and complexity to manage than S corp.
However unlike S Corporation this is not a “Pass through” structure for Tax purposes. The profit of a C corporation is taxed to the corporation when earned, and then is taxed to the shareholders when distributed as dividends. This creates a double tax. The corporation does not get a tax deduction when it distributes dividends to shareholders. Shareholders cannot deduct any loss of the corporation. Since tax of C Corp is lower currently at 21% rate and any distribution like dividend to shareholders is also taxed at hands of shareholders. This can be used for tax planning based on the short and long term objectives of the Corporation and its shareholders. Example, payment of dividend can be deferred in favorable tax years of the shareholders. There are also no requirement for payment of minimum payroll to shareholders and any related payroll taxes. At year end the C Corp files form 1120 as an entity.
A corporation is the most complex form of business organization. Its formation and its internal operations are governed by state law. A business corporation is an entity organized for profit under the laws of one state. Although once the dominant form of business organization in the United States, in most states today more LLCs are formed than corporations. However, the corporation remains a popular and viable option and is still the main choice for publicly traded businesses. Capital can be raised by selling stocks and securities. The corporation has centralized management so the investors do not have to become involved in the day-to-day operations. The major disadvantages to the corporate form of organization are that t is the most expensive to form, the most complex to operate and It is subject to “double taxation” as mentioned.
Limited Liability Company
A Limited Liability Corporation (LLC) is another statutory entity that is gaining popularity. It is a business structure allowed by state statute. Each state may use different regulations. Owners of an LLC are called members. There is no maximum number of members. Most states also permit “single-member” LLCs, those having only one owner. It is neither a partnership nor a corporation, but a “hybrid” entity, with some of the characteristics of each. It is formed, in general, by filing articles of organization with the proper state filing officer. Most of the provisions regulating the internal affairs of the LLC are contained in an operating agreement that is entered into by the owners. An operating agreement is similar to a partnership agreement. In recent years the LLC has become the most popular form of business organization in the United States.
Depending on elections for IRS taxation (via Form 8832 Entity Classification Election) made by the LLC and the number of members, the IRS will treat an LLC as either a corporation, partnership, or as part of the LLC’s owner’s tax return (a “disregarded entity”). Distributions in case there is no election as Corp will attract self-employment tax of 15.3% (Social Security and Medicare) on all profits.
A limited liability company that transacts business in states outside of its state of organization will have to apply for authority to do business in those foreign states. The LLC laws provide that the laws of the state in which a foreign LLC was organized will govern its internal affairs and the liability of its members.
For more information refer the IRS website:
For non US Citizens or those not resident aliens in USA, an option is to form a C Corporation or LLC (at state level) with C Corporation election for IRS Purposes. S Corp is not allowed to them. There are tax deducted at source implications on receipts of income in USA if the owner of entity is not able to show that US tax returns are going to be filed. Regarding which state in USA to register and start the business, factors to consider include business reasons for a particular location (home state), state taxes applicable, franchise taxes and recurring annual costs, ease of doing business, business friendly laws, etc. From a pure business perspective, if you need to open an office, or have a physical presence in a particular state, have employees, have a job site etc. you will need to form an LLC in that state of business. Else you will have to comply with requirements of that state of business and also state of registration, if different, and thus make things more complicated. However if there is no physical present needed, such as consulting business, or most business is in another state, then that other state or other options are available. It is usually advisable to form an LLC in a state without state taxes, such as Texas, and Florida, if state taxes is a big cost so you only have to handle US Federal Taxes. Where options can be considered, Delaware, Wyoming and Nevada are popular states for LLC with trade offs. Though Delaware has ‘in state’ taxes it is considered the most business friendly and a long time favorite. Hence if there is little or no in-state business in Delaware, this is a good option. Nevada similarly has many benefits in the arena of tax, privacy laws and easy to do business. Wyoming is the new kid on the block attracting businesses in its own unique ways. Hence each state has advantages and costs and need to be compared with the business factors faced by the company and the owners or shareholders of the company. It is not one